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Too much of a good thing is never a good thing. Dry powder is no
exception to this rule. With the year coming to a close, and
election uncertainty (mostly) resolved, investors are becoming
increasingly concerned about how the 2013 investment landscape
will change if GPs embrace the ‘use it or lose it’ mentality
often associated with the excess dry power. It seems like there
are only three outcomes to deal with the pressure from the extra
capital.

The first, according to a recent article by Andrew Ross
Sorkin, is dry powder yielding a classic supply-demand
dichotomy -- since there is so much excess capital in the market,
demand is expected to far exceed supply, ballooning the price of
traditional deals to untraditional highs.

Inflated prices could mean bad news for the lower middle market.
As the largest firms begin seeking any available deal, the trend
could carry through the entire industry, with many firms looking
to move down market as prices rise. Such investments could leave
few opportunities for the smaller firms with limited investment
capacities.

The concern for inflated prices was echoed by Stenning Schueppert
of Total Safety in our Corporate Development Report.
He explained that when Total Safety is “pursuing a smaller deal,
[they] are competing with the smaller-cap, mid-market PE funds
with excess dry powder themselves. Given the whole ‘use it or
lose it’ issue, we feel they need to put that powder to work.
And, as a result, they may possible be overpaying for
opportunities.” As the pressure mounts, even strategics may be
impacted by the inflated prices, losing their traditional
advantage of offering higher bids.

However, there is another side to the excess-dry-powder coin.
According to Sorkin’s article, there have been whispers around
the water cooler that the dry powder has piqued the interest of
some firms in going “elephant hunting -- seeking big deals worth
as much as $10 billion -- and are willing to pay a special bounty
for bringing them acquisition targets.” In short, these firms are
looking for mega-deals.

Ah, mega-deals. The term evokes memories of bygone days in the
bullish, excessive 1980s and mid-2000s when private equity shops
bought enormous companies left and right. However, since the
economic crisis, these juggernauts have become nearly extinct.

But, there are murmurs of a resurrection. Although a full return
is less likely than inflated deal prices, there have been
rumors that 2013 might witness a resurgence of mega-deals. As a
series of indicators align -- including dry powder, an abundance
of low-yield bonds, and public market liquidity -- it seems like
massive LBOs may return, which could mean good news for some
lower-middle market firms. The speculation is only fitting --
after all, we are nearing the 24th anniversary of the archetypal mega-deal.

In a recent article, two Bank of America strategists argued
that today’s “historically low yields and the abundant liquidity
in the public markets” are perfect conditions for large deals.
Although deals may start relatively small -- around $5 billion --
deals could reach $20 billion. According to the BoA strategists,
“the most constraining factor for deal size appears to be equity
- not debt.” Disney’s acquisition of LucasFilm may be one
of the incipient, smaller deals.

Although rising deal valuations or mega-deals seem probable given
the amount of dry powder floating around, there are still other
options to deal with the excess. As Primack explained, a third
way for GPs to neutralize their dry powder is by renegotiating
the terms of their funds. For example, rather than
scurrying to meet the nearing fund deadlines, GPs could
retroactively cut the fund size -- a method employed by some VC
firms in the aftermath of the tech bubble burst in the early
2000s. Or, GPs could ask LPs to extend the fund deadline.
Although these requests are usually seen unfavorably, LPs often
have little choice but to accede.